2. During 2010–2011, a series of floods hit Australia, primarily in the eastern

Question

2. During 2010–2011, a series of floods hit Australia, primarily in the eastern coast

areas including Queensland and Victoria. At least 70 towns and over 200,000 people

were directly affected. The estimated damage in Australia’s GDP is about $30 billion

(ABC News Online, 18 January 2011). The floods also took a toll on the potato

industry. As a consequence, the potato market has received a lot of attention.

(a) According to a study on the Australian potato market, at the price of $2.99 per

kilogram, a regular household consumes about 7.6 kilograms of potatoes per

month. The consumption of potatoes drops to 6.5 kilograms per month when

the price is at $4.99 per kilogram.

i. Based on this information, use the mid-point method to compute the price

elasticity of demand for potatoes in a regular Australian household.

Answer: PED= -0.31

ii. There are many ways to categorize the goods in the market. For example,

there are normal goods and inferior goods, regular goods and Giffen goods,

necessities and luxuries, etc. According to your answer in the last question,

what type(s) of good does the potato belong to?

Answer: Regular Goods

iii. Some scholars argue that the estimate of the elasticity calculated in (i)

might be unreliable. Briefly explain why.

Explanation / Answer

The price elasticity of demand is expressed as:

(Change in quantity demanded/change in price) *(actual price/ actual quantity demaded)

= p/q * dq/ dp

Here p = 2.99. dp =( 4.99 - 2.99) = 2 [ p1 = 4.99, p0 = 2.99]

q = 7.6. dq = (6.5 - 7.6) = -1.1. [ q1 = 6.5, q0 = 7.6]

Now putting the values in the formula we get PED = ( 2.99/7.6) * ( 1.1/ 2) = - .22

Here the negative sign implies the inverse relationship between price and quantity demaded. Which further implies that the commodity is a normal commodity.

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